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Accounting & Financial Statement Red Flags for Investors

Let's face it, there are some companies in our portfolio where we bought without completing our due diligence. Maybe Cramer was too convincing or your friend's rationale was logical at the time, but ultimately, it's our money and we only have ourselves to blame if something goes wrong.

To start remedying this situation, here is a list of red flags from Business Journalism that should raise concerns should you find your company following these points.

Many of these points have been raised in the book The Art of Short Selling which I wrote about here.

Red Flags for Investors

  • When a company starts bashing short sellers.
  • When you read the SEC filings and still can't seem to understand what's going on.
  • When you see lots of new footnotes and disclosures, particularly of things that happened years ago.
  • When companies count revenue when items are simply shipped, or they are using a percentage-of-completion method.
  • When there are big gaps between numbers in the press release and in the 10-K/10-Q. Regulation G makes this harder for companies to do today, but it still happens.
  • When companies seem to take special charges/gains, quarter after quarter and year after year.
  • When there are lots of related party transactions with officers and directors. Just because the transaction seems small, don't dismiss it as being insignificant.
  • When publicly traded companies are still run like family businesses.
  • When there are lucrative consulting contracts/severance agreements with current and/or former directors and executives.
  • When there are big increases in director's fees or perks.
  • When there's an inattentive audit committee.
  • When there's a sizable increase in non-audit fees paid to the accounting firm.
  • When the interest rate return on pension fund seems unusually high, or when 20 percent or more of operating income comes from pensions
  • When there are off-balance sheet obligations that had not been previously disclosed.
  • When you see the words "formal" or "informal investigation," "subpoena" or "Wells notice."
  • When there are unusual income tax rates – either unusually low or unusually high. Rates should fall between 30 percent and 40 percent.
View the full PDF here which also includes examples.

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